Risk tolerance can play a large part in determining the structure and composition of an individual's investments and financial plan. As an investor, it’s important to know your risk tolerance for investments and be aware of circumstances that may affect it. Evaluating your risk tolerance regularly can help ensure your portfolio mix is still aligned with your current situation and future goals. Here are five considerations to make when assessing your risk profile:
1. Understand how risk tolerance can affect a portfolio. Investors with conservative profiles are often individuals who have shorter investment horizons or fewer assets. These investors are usually matched to similarly risk-averse investment vehicles, such as bonds. Bonds generally offer lower returns in exchange for their relative safety. A portfolio heavily weighted in stocks is better suited to individuals with a high-risk tolerance. For example, younger investors who have time to bounce back from market fluctuations or investors with ample resources may utilize higher-risk investment options. Similarly, wealthy individuals who are willing to take on more risk for the potential of higher returns might explore IPOs, hedge funds, options and futures and other alternative investments. Most investors find a balance between risky and conservative portfolios. Risk tolerance is a spectrum, and you can find equilibrium in your portfolio as a whole by adjusting the riskiness of individual investments.
2. Changes to your personal life. Big life events such as marriage, divorce, home ownership, parenthood or a job change can impact your risk tolerance. For example, having a baby may compel you to be more cautious about how you manage risk exposure because you’re responsible for an additional member of your family. On the other hand, making the last payment on your mortgage may give you more financial flexibility, and your risk tolerance may adjust accordingly.
3. Changes to external circumstances. Your risk tolerance can be influenced by matters outside your personal sphere of influence. Stock market volatility, inflation and political events can contribute to your ease or discomfort with investment risk. When big external events occur, you may feel compelled to adjust your portfolio. Before doing so, keep two principles in mind: (1) It’s important for your investments to at least keep pace with the rise of inflation over time, overwise your portfolio will lose purchasing power. (2) Staying invested is one of the best ways to weather through market volatility.
4. Consider your confidence with risk. Check your stress level when the market fluctuates. You may not have the stomach for market dips. You also may be less comfortable with risk if you have other reasons to avoid it: you’ve taken on more debt, had a reduction in your income, or have seen an increase in your cost-of-living expenses. Older investors maybe most concerned with safeguarding principal and earning reliable, even if modest, returns. If you have noticed your discomfort with risk increase, speak with a financial advisor about potentially adjusting your portfolio mix.
5. Progress towards goals. Younger investors can usually manage more risk because they have years ahead of them in which to make up for market downturns. A windfall or other improvement in your finances may allow you to take on more risk. Alternatively, drawing nearer to your goals – such as a child’s college enrollment or retirement – may mean you need to take on less risk to protect the money you need. (But remember: retirement investors should also consider that their nest eggs may need to last several decades).
Risk tolerance is not static. Like many aspects of your life, it can change over time. When circumstances shift, it’s wise to evaluate whether your investments are still appropriate. A financial advisor can help you assess the health of your holdings and make adjustments that match your risk tolerance.Together, we can work to keep you on-track towards your financial goals.
Request a consultation with us to learn more.
Read more articles by Encore Wealth Management Group